VideoWhen Swiss insurer Helvetia announced in March that it would buy Italy's Padana Assicurazioni, a small company providing private insurance policies for employees of energy group ENI, formerly its parent, the deal must have been a relief to management and investors alike. Last year, chief executive Stefan Loacker had told reporters that Helvetia wanted to be a player in industry M&A, but that a lack of willing sellers was dampening deal flow. And make no mistake, Helvetia wants — and needs — to grow.
"The clear message that we get from analysts and investors is 'You've delivered some nice results in the last few years. We need to see the growth story now — either that or you give capital back to the shareholders,'" says Paul Norton, Helvetia's CFO since July. "There's clearly an increase in the pressure from a couple of different sides, which leads us to say that we do need to grow."
Investors are one big reason why insurers such as Helvetia are feeling the pressure to build and branch out. Brussels is another. What lies behind this is Solvency II, a European Commission directive due in 2012, which will overhaul the legislative supervision of Europe's insurers for the first time in more than 30 years. Though still at draft stage, the new directive looks set to favour insurers that have diversified their business by requiring them to hold less capital to cover their range of risks. Ratings agency Standard & Poor's reckons that more than a quarter of Europe's 5,000 insurers will face "major strategic decisions" once the new rules are introduced, including whether to get involved in industry M&A.
As it happens, plenty of insurers have already been brushing up on their deal-making expertise as part of overall growth plans. (See "Big Buys" at the end of this article.) Some are targetting emerging markets. Others are branching out into product distribution. But all are being cautious in a quintessentially risky business. The burning question their CFOs are now asking is how to manage M&A strategies at a time when market conditions are making any kind of deal-making so difficult.
While few European insurers have had to announce significant writedowns as a result of exposure to America's subprime crisis, investors seem to have treated insurance much the same as any other financial-services stock — when German bank Sal Oppenheim published a study of insurance consolidation in December 2007, it noted that valuations were close to a ten-year low. The fact is that "every insurance company in the world is getting hammered by the developments in the financial markets," says Joseph Streppel, CFO of Aegon, a Dutch life insurer with revenue-generating assets of €371 billion.
So even though Streppel expects Solvency II to drive deal activity, the current environment for public companies such as Aegon is that "it's pretty difficult to stick our necks out and do a large acquisition," he says. Issuing shares would be tough and few investors would be happy to see the board use surplus cash — Aegon has more than €1 billion — to pay a premium. That said, standing still won't be an option for long as Solvency II approaches.
Root and Branch
One of the main proposals of Solvency II focuses on companies' solvency capital requirements, which will be worked out with a risk-based model, rather than the mathematical formula of Solvency I. If a company underwrites businesses in areas unlikely to run into a crisis at the same time — say, car insurance in the UK and home insurance in the US — Solvency II should require it to hold less capital to cover the combined risks than for either individually.
The beneficiaries are expected to be large, diversified insurers with good risk management processes. Smaller companies with fewer business lines may suffer. "That is bound to lead to some sort of pressure for M&A activity across Europe," says Ian Dilks, global insurance leader of PricewaterhouseCoopers. "Either for big companies taking advantage [of the new regulation] or smaller ones finding that they have to sell out because they're just not going anywhere."
Yet don't expect big-ticket M&A in an environment where it's hard to borrow money "whether you're trying to buy a house or a £7 billion insurance company," says Matt Lilley, an insurance analyst at Lehman Brothers. Rather than encouraging deals between large players that are "obsessed by staying independent," he says current insurance consolidation is likely to involve smaller transactions — lesser players merging or larger companies acquiring smaller businesses as bolt-on buys.
Indeed, at Aegon, bolt-ons are currently all that's on the table. But Streppel says that's not a concern. Despite several acquisitions in the past — the largest being its $9.7 billion takeover of Transamerica in the US in 1999 — the company today focuses on organic growth in its core markets of the US, the Netherlands and the UK. There's now a limit to the synergies that can be achieved by growing through M&A in these markets, Streppel says. "We don't need to expand scale there because our unit costs will probably not be much lower if we double the size of those companies."
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